Experts at Eastspring Investments, the $275 billion asset management business of Prudential, discuss how Japan offers investors multiple opportunities to capture alpha.

Ivailo Dikov, head of Japan equities and James Ying, client portfolio manager at Eastspring Investments, highlighted the re-rating runway of Japanese equities.

The country is transitioning from a deflationary to a reflationary economy, driven by sustained wage growth, inflation, and policy normalisation. Meanwhile, measures such as government subsidies and food reserves aim to ease inflation and boost spending power.

“Corporate governance reforms have also led to improved board accountability, capital efficiency, and shareholder returns. Ongoing regulatory pressure and market activism continue to push companies toward greater transparency and efficiency,” Dikov and Ying said.

Japan has also been able to manage its trade and economic relations with the US, with the two countries coming to an agreement in late July 2025 with a tariff rate of 15 per cent, one of the lowest rates among major economies and more favourable than prior market expectations. The agreement positions Japan as one of the US’ preferred trading partners. It also provides more clarity on Japan’s economic outlook, which may enable the Bank of Japan (BoJ) to continue normalising rates.

Dikov and Ying believe that Japanese equities present a combination of balance sheet strength, governance improvement, attractive valuations, and untapped alpha – especially among small and mid-caps (SMIDs).

Japanese corporates are also unusually well capitalised. “Almost half of the Tokyo Price Index (TOPIX) non-financial companies hold net cash on their balance sheets – far higher than in the US (25 per cent) or Europe (16 per cent),” they continued. This financial conservatism acts as a buffer during turbulence and offers optionality: as corporate governance reforms pressure management to deploy excess cash, Dikov and Ying expect increasing share buybacks and dividends – not just from large caps but also undervalued SMIDs. “This also provides ample dry powder for capex and M&As, which have reached record levels this year and seem poised to maintain the strong momentum,” they said.

“Beyond the well-known large-cap exporters, Japan’s equity market is highly diverse and deep. Significant opportunities exist in sectors tied to domestic consumption and services, many of which remain under-researched and under-owned by international investors,” they continued. “Small-to-mid-cap companies stand out as an untapped source of alpha. These businesses often trade at sizeable discounts to intrinsic value despite strong fundamentals and catalysts for re-rating.” An attributing factor is that they often have minimal analyst coverage – some estimates suggest over 40 per cent have no coverage –making them fertile ground for fundamental stock pickers.

Japan’s forward price to earnings (P/E) and price-to-book (P/B) multiples sit at material discounts to global peers despite rising returns on equity (ROE) and free cash flow yields. “This valuation gap reflects lingering scepticism – rooted in deflationary history rather than current fundamentals – and offers a margin of safety for value investors,” Dikov and Ying said.

“Japan’s unique blend of corporate conservatism, reform momentum, and deeply-discounted valuations provides a broad and deep opportunity set,” they added. “From defensive large caps to undiscovered SMIDs, and from domestic growth stories to global exporters, investors have multiple avenues to capture upside as structural catalysts play out...Japan also presents compelling diversification benefits, underpinned by distinct alpha drivers such as domestic consumption recovery, corporate reform momentum, and de-risked balance sheets.” 

Dikov and Ying highlighted that Japan is undergoing a once-in-a-generation transformation that is fundamentally reshaping its economy, corporate sector, and capital markets. The result is a steady uplift in market-wide ROE and margin expansion that have long-lasting implications for investors.

They are not alone in their views. Ronald Temple, chief market strategist at New-York headquartered Lazard, recently highlighted that Japan appears to be in the early stages of an idiosyncratic improvement story that could positively impact returns over the long term. Vincenzo Vedda, global chief investment officer at German asset manager DWS is also constructive on Japanese stocks. See here.